Inertia in Taylor Rules

Edward Driffill () and Zeno Rotondi

No 720, Birkbeck Working Papers in Economics and Finance from Birkbeck, Department of Economics, Mathematics & Statistics

Abstract: The inertia found in econometric estimates of interest rate rules is a continuing puzzle. Many reasons for it have been offered, though unsatisfactorily, and the issue remains open. In the empirical literature on interest rate rules, inertia in setting interest rates is typically modeled by specifying a Taylor rule with the lagged policy rate on the right hand side. We argue that inertia in the policy rule may simply reflect the inertia in the economy itself, since optimal rules typically inherit the inertia present in the model of the economy. Our hypothesis receives some support from US data. Hence we agree with Rudebusch (2002) that monetary inertia is, at least partly, an illusion, but for different reasons.

Keywords: Monetary Policy; Interest Rate Rules; Taylor rule; Interest Rate Smoothing; Monetary Policy Inertia; Predictability of Interest Rates; Term Structure; Expectations Hypothesis (search for similar items in EconPapers)
JEL-codes: E52 E58 (search for similar items in EconPapers)
Date: 2007-11
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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https://eprints.bbk.ac.uk/id/eprint/26892 First version, 2007 (application/pdf)

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Working Paper: Inertia in Taylor Rules (2007)
Working Paper: Inertia in Taylor Rules (2007)
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